History of Financial Bubbles

“Those who do not learn history are doomed to repeat it.”

This is a saying I heard in my first class of history in high school. It was said as reasoning for studying history and gave a purpose to all the endless lectures. Even though this phrase made complete sense to my high school self, now its meaning starts slowly fading away. What if you can’t see the history that is being repeated, what if it is transparent and unnoticeable until it’s too late? This is the precise problem with financial bubbles. Its growth is so crystalline that it becomes extremely difficult to notice until it bursts in chaos and panic. Or maybe, it is just so hard to see because people are so deeply plunged into the euphoria inside that bubble that they would never expect for it to just simply pop.

Financial bubbles are defined as “[...] an economic cycle characterized by the rapid escalation of asset prices followed by a contraction.”. All of them have the same pattern, five stages: displacement, boom, euphoria, profit-taking, and then finally panic. And there have been many of them through time, and they’ve all been well studied. So why is it that history keeps repeating itself?

Due to the incredible belief of the human-being on anything that seems to bring profit and carry an aura of being unbreakable, or unpoppable in this case. Humans are driven by emotions, they’ll put their money where it brings them a good feeling. From tulip bulbs to mortgage bonds, these bubbles were generated by the reliance on feelings like trust brought to investors. Hence, as much as we study history, and understand the financial bubbles, its patterns, and outlines, investors will always be carried away by their own emotions.

However, it is still imperative to study this economic cycle, as each time it occurs it presents different aspects, as the surroundings of it change every time. Some environments are more proper than others for a bubble to form, as the consequences of its burst also differ. An event that happened in the 16th century in the Netherlands doesn’t have the same impact, even having the same outline, as the same happening in the 21st century in the United States.

Studying history might not avoid repeating past mistakes, but it might give some perspective of a better future and enlightenment before acting.

Bubbles Across the Centuries

Tulip Mania

Financial bubbles have been around for centuries now. Starting in the 16th century with something as curious as tulips. Nowadays you can go to the florist and buy a bouquet of tulips for less than 20 dollars, but at a certain moment in history, one tulip bulb could cost as much as a nice canal house in Amsterdam. When tulips were infected by a virus that caused them to present a different kind of coloring, the speculation built on them became frantic. They thought that the passion for this kind of flower would never end, and it seemed irresistible to join this business as investors were sitting in piles of fortune. However, the worst came and the bubble known as the Tulip Mania burst, bringing the price of a tulip bulb as low as an onion. The collapse was mainly local and didn’t have a huge impact in the economy, however it damaged the trust on financial markets.

South Sea Bubble

As the world timidly started becoming smaller, another opportunity of quick immense wealth appeared in the London markets. After England’s defeat in the war against France, the House of Lords passed the South Sea Bill which would give the company of the same name the right of monopoly on all trades with Spanish colonies of South America. The company underwrote the English National Debt, on a promise of 5% interest from the Government. As expectations rose, the value of South Sea Company’s share did too. Speculation became again frantic with the promise of a flourishing trade with the new colonies. However, it ended up collapsing as the tales were only tales and affected economies beyond the London Market.

Japan’s Real Estate and Stock Market Bubble

As the decades passed by, other factors became impactful on new bubbles. This was the case with Japan's Real Estate and Stock Market Bubble, being filled by overly stimulated monetary policies. With the 50% yens surge in the early 1980s, Japan dove into a recession. In order to offset the situation, a monetary and fiscal stimulus program was created by the Japanese government. However, the policies backfired as they fomented uncontrolled speculation in Japanese stocks and urban lands. With values tripling in 4 years, the bubble ended up bursting in 1991, bringing years of price deflation and stagnant economy growth, known as the Lost Decade.

The Dotcom Bubble

In the 1990s, new factors were brought into the economy, creating an exciting feeling in investors. This euphoric feeling led to the Dotcom Bubble. With the increase in the popularity of the Internet, it created an enormous wave of speculation in this new type of business. Companies achieved multi-billion dollar valuations as soon as they went public, bringing the NASDAQ Composite Index from a level of under 500 in 1990 to 5,000 in March of 2000. However, as all other crazy growths, the index crashed shortly after and started a U.S. recession by October 2002.

U.S. Housing Bubble

In opposition to the previous bubbles, who presented new ventures, in 2008 the burst of an unimaginable bubble happened. There was a solid trust by investors that was piled into real estate due to the mistaken belief that real estate is a safer asset class. The steady growth of U.S. house prices which nearly doubled from 1996 to 2006 and then two-thirds of that increase occurring from 2002 to 2006. Even with all that growth, there were some failure signs, rampant mortgage fraud, condo flipping, houses being bought by subprime borrowers, it all led to an inevitable result. The prices peaked in 2006 only to slide down and result in an average house losing one-third of its value by 2009.This burst triggered a recession not only in the country it happened, but all across the globe, as more and more countries are interconnected.

Conclusion

Even with a clear pattern that can be seen across all bubbles, no matter the century it was in, the surrounding factors were definitely key to the different consequences brought by the bubbles. Starting from tulip bulbs in the Netherlands and coming to the housing market in the United States, these economic events all left their marks through history. It is hard to catch a mistake before it has been made, just as it is hard to notice a bubble before it pops. But definitely not impossible. History doesn’t happen twice, as the world is in constant change, but maybe it can simply be summed to Mark Twain’s quote: "History doesn't repeat itself, but it does rhyme.".

References

A Brief History of Financial Bubbles. (n.d.). Retrieved from https://www.gsb.stanford.edu/insights/brief-history-financial-bubbles

Amadeo, K. (2019, November 20). Critical Events of the 2008 Financial Crisis. Retrieved from https://www.thebalance.com/2008-financial-crisis-timeline-3305540

Clairmont, N. (2018, October 6). "Those Who Do Not Learn History Are Doomed To Repeat It." Really? Retrieved from https://bigthink.com/the-proverbial-skeptic/those-who-do-not-learn-history-doomed-to-repeat-it-really

Kenton, W. (2020, March 23). Learn About a Bubble in Economics. Retrieved from https://www.investopedia.com/terms/b/bubble.asp

Malkiel, B. G. (2020). A random walk down Wall Street: the time-tested strategy for successful investing. New York: W.W. Norton & Company.

Picardo, E. (2020, April 12). Asset Bubbles Through History: The 5 Biggest. Retrieved from https://www.investopedia.com/articles/personal-finance/062315/five-largest-asset-bubbles-history.asp

What Caused the Housing Bubble? (n.d.). Retrieved from https://www.realclearpolitics.com/articles/2015/02/02/what_caused_the_housing_bubble_125463.html